The Political Economy of Bilateral Bailouts

Abstract

AbstractIMF loans during times of financial crisis often occur in conjunction with bilateral financial rescues. These bilateral bailouts are substantial in size and a central component of international cooperation during financial crises. We analyze the political economy of bilateral bailouts and study the trade-offs that potential creditor governments experience when other countries find themselves in financial distress. Creditor governments want to stabilize crisis countries by providing additional liquidity, particularly if the crisis country is economically or politically important to them, but they are constrained by domestic politics. Politicians aim to balance these countervailing pressures. They provide bailouts when their own economy is exposed to negative spillover effects and when the crisis country is important for geostrategic, military, or political reasons. Domestic economic and political constraints, on the other hand, limit their ability to bail out other countries. We test our hypotheses using an original data set on bilateral bailouts by the G7 countries to countries that experienced financial crises between 1975 and 2010. The findings of our statistical analysis support our theoretical argument and contribute to a deeper understanding of international cooperation's complex structure during financial crises.